No. 29: Can supervisors enforce transparent accounting when the rules leave room for management discretion?

Year: 2023
Type: Working Paper

Abstract

Supervisors frequently use formal enforcement tools to intervene in banks’ financial reporting. However, when managers exercise their discretion within the boundaries of accounting rules, supervisors have to turn to soft and informal actions to nudge, rather than force banks to change their reporting. While informal interventions are generally unobservable, the Asset Quality Review (AQR) revealed the new supervisor’s preferred valuation of assets when the European Central Bank (ECB) took over the supervision of Eurozone banks. We find that banks adjusted their loan valuation to the ECB’s reporting preferences even if their prior choices were fully compliant. This effect is weaker if a strong local supervisor interferes with central supervision, pointing to the relevance of supervisory consistency in soft enforcement. The reporting changes are associated with greater informativeness of bank earnings, indicating that supervisors’ influence on bank reporting goes beyond the assurance of formal compliance and explains bank-level transparency.

Participating Institutions

TRR 266‘s main locations are Paderborn University (Coordinating University), HU Berlin, and University of Mannheim. All three locations have been centers for accounting and tax research for many years. They are joined by researchers from LMU Munich, Frankfurt School of Finance and Management, Goethe University Frankfurt, University of Cologne and Leibniz University Hannover who share the same research agenda.

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